Quarterly Letter to Clients October 1999

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Quarterly Letter to Clients

January, 2000

Indices at quarter-end (December 31, 1999):

Dow Jones Industrials: 11,497.12 4thQ'99: +11.22% YTD: +25.22%

Standard & Poor's 500: 1,469.25 4thQ'99: +14.54% YTD: +19.53%

Goodbye Y1K!

As is fitting, we finished the year (and, yes, the century, and the millennium) with all of the major averages (save bonds) posting all-time highs. This was in marked contrast to the preceding quarter, which was negative for stocks and bonds.

But breadth continued to narrow. This means that the average stock did not participate in the rally. Technology stocks, and especially Internet offerings, were the leaders, and these creatures mostly dwell over on the NASDAQ, which had a stunning gain of over 85%. Of that average, perhaps 10% of the stocks accounted for the largest part of the move. The price-earnings ratio of the NASDAQ is now approaching 200--and there's not even a dot between Qual- and -comm.

Roughly one-third of NYSE stocks were up for the year. Two out of every three were down. Transports, Financials and Utilities were generally negative. The NYSE Composite, an average of all stocks traded on that venerable exchange, was up 9.15%, a much more accurate reflection of the true overall market than the now closely-managed Dow-Jones Industrials or the tech-heavy Standard & Poor's 500.

With just a modicum of digging you can easily find many giant, blue-chip, household-name companies that were lower not just for the year, but for the entire decade. It becomes readily apparent just how difficult a market it has been of late. This is certainly not evident from the averages, and I would not look for it to get easier.

Bonds were sharply negative, echoing 1994's poor showing. One important observation: the relationship between stocks and bonds has now fully reversed. This is the second time that this has happened in my lifetime. The implication is that, now, when stocks go up, bonds go down, and vice-versa.

Along with the new millennium, we have the "e" economy. Not only mail, but commerce, retailing, businesses of all types--including mine--get tagged with an "e-" preface or a "dot com/net/org" suffix.

It seems that the market recognizes two types of companies: those of the "new" economy, and those of the "old". Wall Street, in its infinite wisdom, says that a new economy stock is a good buy at, say, 30 to 50 times sales, while an old economy stock is unattractive at 10 to 12 times earnings. Bricks versus clicks. Perception versus reality.

Tech stocks, by capitalization, now account for around 30% of all U.S. stock market value. But the "bricks"--the reality--has been around for a very long time, and while the odds are that they will change the way they sell their products and services, they are not likely to disappear. Good values can be found in these issues, but when they may prove rewarding is a much more difficult guess.

Quite a bit of discussion revolves around the comparison of today's internet stock explosion with the biotech stock boom at the end of the previous decade. More than a few pundits foresee the repeat of the implosion that the biotechs ran into. While I am firm in my belief that the technology of the day will change the way we live and do business, the problem I have is with the valuations that are assigned to companies whose success is dependent upon very rapidly evolving technologies.

It seems logical to me that at some point the stock prices of these companies must realign to reflect their earnings realities. And, just as with the biotechs, there will be survivors, and some who will thrive, while many will fall by the wayside. When the market decides to sort it all out, you will not want to be holding most of those stocks.

I guess my question is, if the '90's is remembered as the "e-decade", will the '00's be remembered as the "e-debacle"?

As we enter the new millennium, I wish you health, happiness and prosperity.

Jim Pappas